A Trust For Creditor Protection

Trusts come in many shapes and sizes and serve different purposes. For instance, you might set up a credit shelter trust to provide wealth for your children and grandchildren while minimizing estate taxes. Another specialized trust—the domestic asset protection trust (DAPT)—is intended to keep assets from the reach of creditors even if you're named as beneficiary of the trust. DAPTs are available in more than a dozen states.

Although these trusts have been around for years, state laws that set the rules for them continue to evolve. Most state statutes allow a DAPT to be treated as a "grantor trust," meaning that you—the grantor—pay the income tax generated by the trust. Typically, you'll transfer to the DAPT securities, real estate, or other assets that could be targeted by creditors.

This arrangement may be ideal if you're in a "high-risk" profession—for example, if you're a physician, an attorney, or a business executive with sufficient wealth to make you a worthwhile target. Indeed, in today's litigious society, anyone with deep pockets could be sued. A DAPT can remove some of your concerns.

If the idea appeals to you, it's important to set up a DAPT before you need protection from creditors because most states that allow DAPTs have a required waiting period before protections kick in. Moreover, if you move assets into a DAPT after you've been sued or threatened with a suit, you could be accused of making a fraudulent transfer.

Yet as helpful as it can be a DAPT isn't a panacea for all your problems. For instance, most states' DAPTs include a "creditor exception" statute that might provide access to DAPT assets. Such provisions often protect a divorcing spouse who might otherwise lose out on assets that have been transferred to the trust.

Bankruptcy proceedings may also complicate your use of a DAPT, and again, the applicable laws vary from state to state. Finally, a DAPT is irrevocable—you can't undo it. Your attorney and other advisors can tell you whether this kind of asset protection would be worthwhile for you.